2023: China is running away with strategic industries

China now dominates the strategically important industries in ITIF’s Hamilton Index, producing more than any other nation in absolute terms and more than all but a few others in relative terms. Its gains are coming at the expense of the United States and other G7 and OECD economies, and time is running short for policymakers to mount an industrial comeback.

KEY TAKEAWAYS

• As of 2020, China was the leading producer in seven of the ten strategically important industries in ITIF’s Hamilton Index. Overall, China was producing more than any other nation—and more than all other nations outside of the top 10 combined.

• Hamilton Index industries accounted for approximately the same share of the global economy in 2020 (11.8 percent) as in 1995 (11.9 percent), underscoring how the race for global advantage in these industries is a zero-sum competition.

• China’s gains have come at the expense of the United States and other G7 and OECD economies. From 1995 to 2020, China also captured more than 80 percent of non-OECD countries’ gains.

• China is 70 percent more specialized than America in advanced industries. To match China’s specialization, U.S. output would have to expand by $1.5 trillion (69 percent), which would require doubling output from all Hamilton industries except IT services.

• Time is running short to turn around U.S. advanced industry fortunes. The 2020s are likely to be the decisive decade because once China captures sufficient global market share, U.S. and allied nations’ production risks being permanently weakened.

• Congress should make closing this massive advanced-industry output gap its overarching economic policy goal, including through tax, trade, and other elements of a comprehensively focused national industry strategy.

INTRODUCTION

Nations are in a fierce win-lose global competition for market share in advanced, traded-sector technology industries because, for most, winning enables economic and national security. That is especially true for allied nations, as China’s gain usually comes at its loss and vice versa. Winning—not only the competition for innovation leadership but also for production capacity—will boost international competitiveness and economic and national security.

When it comes to U.S. national interest, innovation-based production is key. The United States has a long history of pioneering innovations only to see its production captured by other nations, including China. This reduces growth, weakens the terms of trade (creating a higher trade balance, a weaker dollar, or both), degrades the national security industrial base, and makes America vulnerable to industrial pressure tactics from China.

To assess U.S. and other nations’ performance, the Information Technology and Innovation Foundation (ITIF) has examined changes in global shares of value-added output in 10 advanced industry sectors its Hamilton Center on Industrial Competitiveness has aggregated into the Hamilton Index of Advanced-Technology Performance: pharmaceuticals; electrical equipment; machinery and equipment; motor vehicle equipment; other transport equipment; computer, electronic, and optical products; information technology and information services; chemicals (not including pharmaceuticals); basic metals; and fabricated metals. To conduct this analysis, ITIF uses production data from the Organization for Economic Cooperation and Development’s (OECD’s) dataset on trade in value added, covering the period from 1995 through 2020, and ITIF’s analysis focuses on 40 countries included in that dataset.1 Because of problems with how Ireland’s output is reported, it is not included in the analysis or in EU-wide aggregate data.2

The 10 industries included in the Hamilton Index together accounted for more than $10 trillion in global production in 2020 (figure 1). The information technology (IT) and information services industry (including software and Internet services) is the largest of the 10, accounting for 18 percent of global advanced industry output.

Figure 1: Global output from industries included in the Hamilton Index, 2020 ($10.1 trillion, total)

The 10 industries’ collective production represented 11.8 percent of the global economy in 2020, about the same as 25 years prior, having rebounded from a dip to 10.6 percent following the global financial crisis of 2008 that saw steeper declines in goods output than overall gross domestic product (GDP). (See figure 2.) However, the mix has changed, with the IT and information services share growing 34 percent since 2002. The fact that the overall share of the global economy comprising this advanced industry output has not changed underscores the zero-sum competition between nations. Indeed, there is a noticeable correlation between strength in these industries and nations’ balance of trade. (See Appendix B: Advanced Industries’ Relationship to National Trade Balances.) Nations are, or at least should be, competing intensively for a greater share of this fixed pie. China certainly is. For the United States, losing this race, either because policymakers are indifferent to the country’s industrial structure or because they choose to focus on other economic or societal goals, would be catastrophic, as it would turn the United States into a deindustrialized, United Kingdom-like economy. Time is short. The 2020s are likely to be the decisive decade in which to turn around U.S. advanced industry fortunes, because once China gains sufficient global market share, allied and U.S. production risks being permanently weakened.

In several reports, ITIF has laid out a comprehensive advanced industry strategy.3 But notwithstanding the passage of the CHIPS Act, the political will in the United States to implement and fully fund such an agenda appears to be relatively low, especially as neither political party wants to address the massive budget deficit to free up needed funding for such a strategy.

Figure 2: Hamilton industry shares of the global economy

Of course, global market shares of the advanced industries cannot serve as the only metric of national competitiveness—or even the primary one—because nations have different-sized economies. To assess nations’ relative performance in strategically important industries, ITIF uses an analytical statistic known as a “location quotient” (LQ), which measures any region’s level of industrial specialization relative to a larger geographic unit—in this case, a nation relative to the rest of the world.

The LQ is calculated as an industry’s share of a country’s economy divided by the global industry’s share of the global economy, or as a country’s share of global output in an industry divided by the country’s overall share of the global economy. Either way, an LQ greater than 1 means the country’s share of global output in an industry is greater than the global average; and an LQ less than 1 means a country’s share is less than the global average. For example, the U.S. motor vehicle industry’s output in 2020 was 14.01 percent of global motor vehicle production, while the U.S. economy overall was 24.71 percent of the global economy. Thus, the U.S. LQ in the motor vehicles industry was 14.01 percent divided by 24.71 percent, or 0.57, meaning the United States significantly underperformed in the industry: Its output (and global market share) was just 57 percent of the level we would expect based on the size of the U.S. economy.

OVERALL FINDINGS

Specialization Rankings

Figure 3 ranks 40 countries by their relative performance (LQ) in the composite Hamilton Index based on the most recent data available from the OECD. Fourteen countries have LQs above average for the composite output of the 10 industries, with Taiwan ranking first at 2.1 (with almost all of that driven by its computer and semiconductor output). Three other East Asian nations—Korea, Singapore, China, and Japan ranked second, third, fifth and seventh, respectively. This in large part reflects the focused and dedicated advanced industry policies these nations have had in place for the last several decades. Engineering and chemical industry-intensive nations of Switzerland, Germany, Sweden, and Austria ranked fourth, sixth, ninth, and eleventh, respectively.

Several developing countries ranked low, with LQs below 0.5, including Egypt, Bangladesh, Pakistan, and Nigeria. In addition, natural resource-intensive nations such as Canada, Saudi Arabia, Australia, and Norway all ranked low.

The United States’ LQ was 0.87, meaning that as a share of U.S. GDP, these industries collectively are smaller than the global average. For the U.S. LQ to be 1.0, advanced industry output would need to expand by $328 billion, or 15 percent. This would be equivalent to doubling America’s computer, electronics, and optical products industry output.

Some will argue that it’s acceptable or even normal for the U.S. LQ to be this low because it is a large economy and one where the share of GDP that is globally traded is below average. But LQ is not a measure related to trade; it’s a measure related to production. Moreover, there is a small, positive correlation between national GDP and LQ (0.12), suggesting that the U.S. score should be above average, not below. The reality is America’s low LQ reflects failure, not success; weakness, not strength.

Figure 3: Relative national performance in the composite Hamilton Index (2020 LQ)

When it comes to relative change in LQ, the story is somewhat different. From 1995 to 2002, Taiwan and Korea led in LQ growth. (See figure 4.) Several European nations also increased significantly, including Switzerland, Austria, Denmark, and Germany. Russia increased its score by almost 25 percentage points as it overthrew the straitjacket of Soviet communism and got out from under export controls that the Western Bloc established during the Cold War. The United States’ LQ fell slightly by 8 percentage points.

Figure 4: Change in relative national performance in the composite Hamilton Index (LQ difference, 1995–2020)

Some industries are more concentrated than others. For example, the country that is most specialized in machinery and equipment production, Germany, had an LQ of 2.02, whereas Taiwan outperformed even more dramatically in computers and electronics with an LQ of 8.79. (See table 1.) Some of this is because leading specialists such as Taiwan, Switzerland, Singapore, Mexico, and Israel are relatively small, making it easier for an industry they specialize in to dominate their economy. But in other cases, it is because industries such as machinery, chemicals, and electrical equipment are much broader and have wider arrays of sub-industries.

Table 1: Hamilton Index industry leaders, 2020

Between 2008 and 2020, more countries have declined in their relative specialization, in part because of faster growth outside the 40 nations covered. Taiwan continued to specialize in advanced industries, almost exclusively because of its growth in computers and semiconductors (figure 5). Mexico grew by 9 percentage points, largely due to expansion of its automobile sector. The United States grew slightly, essentially treading waters since it was struck by the China shock of the 2000s. More importantly, rapid growth in the U.S. IT and information services sector more than offset continued decline in manufacturing. In this sense, strong performance in the IT services sector, including firms such as AWS, Google, and Meta, has masked a continued decline in advanced goods production.

Perhaps most surprising is that China ranked last, with its LQ peaking in 2009 and declining by 33 points by 2020. The reason was not necessarily an ineffectiveness of Chinese advanced industry policy, but rather its enormously fast economic growth, which would lead to lower LQs unless advanced industry grew as fast. In fact, China’s advanced industry output grew by 177 percent from 2008 to 2020, more than double the U.S. growth of 78 percent. Only Bangladesh and Vietnam saw greater output growth than did China.

Figure 5: Change in relative national performance in the composite Hamilton Index (LQ difference, 2008–2020)

Relative Momentum

LQs and change in LQs are useful indicators, but they don’t consider differences in industry size. If a small industry’s high LQ (or strong LQ) growth might be completely offset by a large industry with modest LQ. To account for this, ITIF has developed a momentum index. (See figure 6.) This is the sum of the 10 industries’ value-added output divided by their GDP, after first multiplying each industry’s 2020 output by its 2020 LQ and the percentage change in its LQ since 2008 (added to 1).

The results are striking. Taiwan far exceeds any other nation, with an index of momentum of 1,503, almost double Singapore’s score of 836 and more than double Korea’s, with all three nations’ strong scores due principally to computers and semiconductors. Switzerland ranked third, Denmark fifth, and Belgium ninth with over 70 percent of their momentum coming from the pharmaceutical sector. Almost all of Mexico’s strong score was due to the motor vehicle sector, while 40 percent of Germany’s score also came from this sector. Meanwhile, 75 percent of Israel’s momentum came from IT and information services.

The U.S. momentum score from 2008 to 2020 was slightly below the global average, with 53 percent of its score coming from IT and information services. If this sector were the average size and growth, then it would only account for 29 percent of the U.S. momentum score, which would have fallen to just 79.

China’s momentum score was more than twice that of the United States and was relatively diversified, with basic metals being its strongest industry, followed by machine equipment then computers and electronics.

Figure 6: Index of momentum in all Hamilton industries from 2008 to 20204